Jonsson, Gunnar

Stockholm University, Faculty of Social Sciences, Institute for International Economic Studies.

1995 (English)Report (Other academic)

Abstract [en]

This paper develops a simple positive model of monetary policy that allows for persistent unemployment. Monetary policy incentives are thus studied in a dynamic context, rather than in the more common repeated game setting. The main results are as follows: When unemployment is persistent, the credibility problem implies both a more severe inflation bias as well as stabilization bias. However, a simple state contingent performance contract eliminates both biases. Moreover, if policymakers with different preferences alternate in office following general elections, monetary policy becomes subject to various strategic political considerations. Monetary policy is used to influence future policymaking by affecting future government's incentive constraints, but it is also used to increase the incumbent's probability of re-election. The resulting political business cycle in monetary policy is fundamentally different for left-wing and right-wing oriented governments.